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Wednesday, June 25, 2008

Dorothea Lange Boundary County October 1939 "Father and son have cleared thirty acres of raw stump land in three years. Boundary County, Idaho."

Ilargi: Update 2.00 PM. Earlier this week, I received a copy of an Elliott Wave report. I can’t publish these reports, since they’re paid subscription only. Rest assured, it is something else: an overview of how deep respective countries and their populations are mired in the real estate doghouse. And Europe looks very bleak, far bleaker than the US.

This morning, I got this little -for publication- summary. The only comment I have is that I can’t see how the US numbers (which I can’t publish) in the report correspond to this particular graph (which I can); I think the US numbers should be higher, perhaps about on par with Italy. That aside, countries like Spain, Ireland, the UK and the Netherlands would still look much worse than the US. People in these countries need to wake up; they're about to be hit by a financial earthquake. The report can be purchased at elliottwave.com

If you think that the real estate situation is bad in the United States, take a look at Europe.

In his new study, "The European Housing Mania," Elliott Wave International's Alan Hall forecasts that the housing mania in Europe is reaching its end and could make the U.S. housing mania pale in comparison. He bases his forecast on historical perspectives of European markets and comparative studies of Japanese and U.S. housing markets, as well as on Elliott wave analysis.

His research also leads him to 1) a general target area for the decline in U.K. real estate valuations and 2) an account of the European countries at risk for the deepest collapse in real estate prices.

The article includes 12 charts that compare the markets in 10 European countries, plus Japan and the United States. Hall also does a comparative risk assessment of real estate markets in Spain, Ireland, Switzerland, Denmark and the Netherlands. Here's an excerpt from The European Housing Mania that includes both a chart and commentary:

"Figure 5 shows total RMBS issues expressed as a percentage of GDP for nine countries. The U.K. still leads, but Ireland, the Netherlands and Spain also embraced the securities at the heart of the collapsing debt structure. Although Deutsche Bank and Société Générale bought into the mania, Germany and France seem to have generally avoided direct participation. The surprise is the United States, which, when compared to Europe, looks like the epitome of fiscal conservatism. For this puny ratio the firm of Bear Stearns no longer exists? Either the 'subprime' debacle in the U.S. was much ado about nothing, or the havoc wreaked on the U.S. financial system and economy by a relatively low ratio of RMBS to GDP bodes far greater ill for much of Europe when their own bubbles burst."

In addition, Hall shows what the real estate mania looked like in Japan and how it compares with that in the United States and Europe. He comes to the conclusion that what the United States has been going through is merely a "mild prelude of what could happen in Europe."

Hall makes that forecast based on European countries' stronger dependence on debt financing for real estate than the United States: "The bubbles bursting in the U.S. and Europe carry more deflationary potential than Japan's did, because far more extensive credit leverage fueled today's historic mania. With U.S. and British consumers loaded with record levels of debt, their economic stress may be worse than Japan's was," he writes.

All in all, it's a fascinating study that comes at the real estate markets from a different point of view – Elliott wave analysis –while pointing out that history seems to be repeating itself (from Japan's housing collapse to the U.S. housing collapse to a European housing collapse).

The Federal Reserve left its benchmark interest rate at 2 percent, ending the most aggressive series of rate cuts in two decades, as higher energy costs threaten to boost inflation.

"Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased," the Federal Open Market Committee said in a statement today in Washington. Fed Chairman Ben S. Bernanke and his colleagues refreshed their forecasts at their two-day meeting and reported that the economy continues to expand. At the same time, crude oil prices have almost doubled in the past year and the cost of commodities from wheat to tin jumped to unprecedented levels.

"The Committee expects inflation to moderate later this year and next year," the Fed said. "However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high."

Treasuries, which had fallen before the statement, dropped to their lows of the day before rebounding. Two-year note yields were 2.93 percent at 2:26 p.m. in New York, from 2.84 percent late yesterday. The Standard & Poor's 500 Stock Index was up 1.2 percent at 1,329.37. The dollar weakened against the euro.

"It is more or less a neutral statement, which is consistent with policy on hold pending more clarity," said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. "They are not tipping their hand for the next meeting." As policy makers convened, reports showed U.S. home prices fell the most on record, consumer confidence touched a 16-year low, and durable goods orders were unchanged in May. Households are also falling further behind on their debt, eroding profits at lenders. Banks and securities firms have taken almost $400 billion in asset writedowns and credit losses.

"Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters," the Fed said. Dallas Fed President Richard Fisher dissented from today's decision, preferring an increase. He dissented against the rate cut at the April meeting.

Ilargi: Countrywide shareholders will today -in secret(?!)- agree to be sold to Bank of America. Turns out, it’s a great deal all along, because the IRS permits BoA to write down Countrywide losses smeared out over many years, setting up taxpayers to foot that bill as well.

It’s hard to grasp for some, perhaps, that this sort of criminal activity is being performed right before their eyes, but there’s only one good piece of advice here: get used to it. This is the Bulgaria Model. It's all about sharing. Bank of America gets the profits, you get the losses.

At the same time, the Senate will, as early as today, agree on the Shelby/Dodd housing rescue bill, which as we know now was written by BoA, Countrywide and their lobbyists. Looks like slam dunk hole-in-one, all across the board.

But it may not be that easy, because also -coincidentally?- today, Illinois becomes the first state to officially sue Countrywide, as well as its capo, Angelo Mozilo. Rumor has it that California will soon follow, and that could mean there’ll be a large number of similar lawsuits coming up.

Which would mean that Angelo’s friends, the Washington crowd with their favorable mortgages, will scramble to get their fingers out of the pie, and leave Angelo hanging out to dry. Not unlike what happened to Enron’s Ken Lay. He's no use to them anymore.

And now I'm starting to think: Wait a minute: have they planned this all along? But that's just me.

Two other items to watch in the coming days and weeks: GMAC, GM's financing unit, which has $60 billion worth of paper toeing the crumbling edge of the abyss (GMAC is bigger in "assets" than Countrywide), and long time favorites Fannie and Freddie, who I predict will be the biggest scandal and cause the biggest losses, write-downs and write-offs, trillions of dollars worth of them, in the District of Bulgaria.

Update 1.00 pm EST: Confirmed by WSJ, see below: Countrywide shareholders have approved the sale -merger if you will- to BoA, and California have filed their lawsuit. Mozilo may regret having to go up against Jerry Brown.

NOTE: BoA and Countrywide shares are up on Wall Street. Wonder how long that’ll last.

The global economy would collapse if oil hit $200 a barrel, said the top energy analyst at Germany's largest bank. "Two-hundred dollar oil would break the back of the global economy," Deutsche Bank AG's Chief Energy Economist Adam Sieminski said in an interview today in Tokyo. "Next step after $200 would be global recession and bad news for everybody."

Sieminski's comments come after Goldman Sachs Group Inc. forecast oil may rise to between $150 and $200 within two years as supply growth, especially from producers outside the Organization of Petroleum Exporting Countries, fails to keep pace with demand. Deutsche Bank is due to release its oil-price forecast on June 27.

Russia, a non-OPEC producer and the world's biggest oil exporter after Saudi Arabia, faces its first annual decline in production in a decade. Prime Minister Vladimir Putin pledged to reduce taxation on the industry to stimulate investment in aging fields and new regions. Output fell 0.9 percent to 9.76 million barrels a day in the first five months of the year.

"Growth last quarter fell on a year-on-year basis, and this has to do with the policies implemented over the prior year to raise taxes on oil industries," Sieminski said. "This made it difficult for foreign capital to come in. "If Russia could reverse some of these policies and get their own oil industry back on, this will help very much."

Bank of America Corp.'s $3 billion takeover of Countrywide Financial Corp. will be financed by 138 million tax-paying Americans.

Bank of America, led by Chief Executive Officer Kenneth Lewis, can use tax write-offs to pay for Countrywide, the country's biggest mortgage lender, said Robert Willens, a former managing director at Lehman Brothers Holdings Inc. who now runs his own accounting firm. Taxpayers may pick up about $5 billion of Countrywide's losses over 20 years, he said. Countrywide shareholders vote on the sale today.

"Ken Lewis got a break," Willens said. "What these losses do is reduce the effective cost of the deal so the headline price isn't really what they're paying. It's entirely possible that the entire equity purchase price could be financed by tax savings." The tax benefit may explain why Lewis continues to back the purchase even as analyst Paul Miller of Friedman, Billings, Ramsey Group Inc. said he should "walk away."

Miller, the top- ranked analyst in Bloomberg's latest survey of stock-pickers, estimates Countrywide will lose as much as $33 billion on bad home loans. Lewis said this month Bank of America, the biggest U.S. consumer bank, will come out ahead even if home prices drop by more than 25 percent in the next two years. "Sometimes that's a reason why companies that don't look like they're worth much get acquired," said Bob McIntyre, director of the Washington-based Citizens for Tax Justice. "It's to keep their tax assets from being wasted."

Bank of America spokesman Scott Silvestri declined to comment and calls to Countrywide spokeswoman Ginny Zoraster weren't immediately returned. Calabasas, California-based Countrywide will give Bank of America, run since 2001 by the 61- year-old Lewis, about a quarter of the U.S. mortgage market. Tax law limits for five years the deductions an acquiring company can take on the losses from the company it purchases, Willens said.

The amount Charlotte, North Carolina-based Bank of America can write off is based on its equity in Countrywide -- the $3 billion purchase price plus $2 billion the bank invested last August -- multiplied by what's called the long-term tax- exempt rate, which changes daily and currently is about 4.5 percent, he said. Bank of America's deductions will total more than $1 billion over the first five years, Willens estimates. After that, the deductions depend on how much the bank earns and how much Countrywide loses, he said.

Based on Countrywide losses of $30 billion, which are less than Miller's estimate of $33 billion, Bank of America would more than recoup the entire $3 billion purchase price, Willens said. The U.S. Internal Revenue Service can disallow deductions if the principal purpose of an acquisition is avoiding or evading federal income tax, according to Section 269 of the tax code.

"This isn't a tax-driven transaction, but I'd be surprised if you told me the Bank of America tax lawyers were locked out of the room when they made the decision," said Howard Rothman, chairman of the tax department at Kramer Levin Naftalis & Frankel LLP law firm in New York.

Writing off Countrywide's losses reminds Frank Hirsch, a Raleigh lawyer, of how North Carolina National Bank, a Bank of America predecessor, in 1988 bought First Republic Bank, the largest in Texas, in a government-assisted rescue that included an estimated $2.9 billion in tax incentives.'NCNB purchased 20 percent of First Republic for $210 million with an option to buy the rest from the Federal Deposit Insurance Corp. for $840 million within five years, according to Ross Yockey's biography of retired Bank of America CEO Hugh McColl Jr. First Republic, with $26 billion in assets, was reporting rising losses from real estate loans as declining oil prices slammed the Texas economy.

The IRS in 1988 allowed NCNB to deduct First Republic's previous losses to offset other NCNB income. Using those losses "turned out to be a brilliant way for what was then called NCNB to enter Texas," said Hirsch, a banking lawyer at Nelson Mullins Riley & Scarborough who previously worked in Charlotte.

The Senate was expected to approve as soon as Wednesday the biggest government program yet to tackle a deep housing market slump feared to be dragging the economy into recession. The legislation would create a $300 billion fund to help up to 400,000 troubled homeowners refinance costly, exotic mortgages into more affordable, government-backed loans. It easily cleared a Senate test vote by an 83-9 vote on Tuesday.

The bill is opposed by the White House but supported by Democrats and many Republicans. It would also overhaul regulation of Fannie Mae and Freddie Mac, the government-sponsored enterprises that are the largest U.S. mortgage financing companies. If the Senate approves it, the bill would have to be reconciled with a similar measure already passed by the House of Representatives.

Lawmakers hope to send a final package to President George W. Bush by mid-July. The two main Democratic authors of the legislation, Massachusetts Rep. Barney Frank and Connecticut Sen. Christopher Dodd, met face-to-face on Tuesday. The White House signaled on Tuesday that it could support the bill if lawmakers trimmed certain spending provisions.

"The most significant concern that we have with the bill is that it would provide for $4 billion to states to purchase already foreclosed homes," Bush administration spokeswoman Dana Perino told reporters. "And our concern is that that just helps the banks, that doesn't the consumers." Treasury Secretary Henry Paulson said some part of the Senate bill are objectionable and the Bush administration wants them changed. He declined to say whether the White House would veto the bill.

Alabama Sen. Richard Shelby, the main Republican architect of the housing package, said he expects that some spending will be dropped before the bill is presented to Bush. "I think at the end of the day, we will knock that out," Shelby said of the state grants, in remarks to reporters.

California's attorney general has filed a civil lawsuit alleging that Countrywide Financial Corp. engaged in deceptive advertising and unfair competition by pushing borrowers into risky loans. The 46-page complaint also names Countrywide chairman Angelo Mozilo and the company's president David Sambol.

"Countrywide exploited the American dream of homeownership and then sold its mortgages for huge profits on the secondary market," California attorney general Edmund G. Brown said in a statement. The lawsuit alleges that Countrywide "viewed borrowers as nothing more than the means for producing more loans" and originated loans "with little or no regard to borrowers' long-term ability to afford them and to sustain homeownership."

These practices "were created and maintained with the knowledge, approval and ratification of" Mr. Mozilo and Mr. Sambol, it alleges. The Illinois attorney general's office, which began an investigation into the business practices of Countrywide last fall, also filed a civil suit against Countrywide and Mr. Mozilo on Wednesday.

In a draft of the Illinois complaint obtained Tuesday, the state alleges that Countrywide engaged in "unfair and deceptive practices" in the sale of mortgage loans. The 78-page document says the company loosened its underwriting standards, structured loans with "risky features" and engaged in "marketing and sales techniques" that incentivized employees and mortgage brokers to push loans whether or not homeowners had the ability to repay them.

Illinois Attorney General Lisa Madigan says she is asking that all Countrywide loans originated using "unfair and deceptive" practices be rescinded or modified in some way, even if Countrywide has to repurchase the loans. She is also asking that her office be given 90 days to review any loans that are currently in foreclosure or that are moving toward foreclosure.

The suits came as Countrywide shareholders approved Wednesday the company's takeover by Bank of America.

The Illinois attorney general is suing Countrywide Financial, the troubled mortgage lender, and Angelo R. Mozilo, its chief executive, contending that the company and its executives defrauded borrowers in the state by selling them costly and defective loans that quickly went into foreclosure.

The lawsuit, which is expected to be filed on Wednesday in Illinois state court, accused Countrywide and Mr. Mozilo of relaxing underwriting standards, structuring loans with risky features, and misleading consumers with hidden fees and fake marketing claims, like its heavily advertised “no closing costs loan.” Countrywide also created incentives for its employees and brokers to sell questionable loans by paying them more on such sales, the complaint said.

In reviewing one Illinois mortgage broker’s sales of Countrywide loans, the complaint said the “vast majority of the loans had inflated income, almost all without the borrower’s knowledge.” The civil lawsuit asks for an unspecified amount of monetary damages and requests that the court require Countrywide to rescind or reform all the questionable loans it sold from 2004 through the present.

The attorney general, Lisa Madigan, also asked that Mr. Mozilo contribute personally to the damages and that the court give her office 90 days to review loans serviced by Countrywide that were in foreclosure or soon would be. “People were put into loans they did not understand, could not afford and could not get out of,” Ms. Madigan said.

“This mounting disaster has had an impact on individual homeowners statewide and is having an impact on the global economy. It is all from the greed of people like Angelo Mozilo.”The lawsuit adds to the considerable legal risks facing Bank of America as it prepares to absorb Countrywide in a takeover announced in January.

Countrywide and its executives have been named as defendants in shareholder lawsuits, and the company’s practices are the subject of investigations by the Securities and Exchange Commission, the F.B.I. and the Federal Trade Commission, which oversees loan servicing companies. The United States Trustee, a unit of the Justice Department that monitors the bankruptcy system, has also sued Countrywide, contending that its loan servicing practices represent an abuse of the bankruptcy system.

Countrywide, once the nation’s top mortgage lender, has watched its fortunes plummet as the housing crisis has spread across the country. In the last three quarters, the company reported $2.5 billion in losses, and in the first quarter of 2008, total nonperforming assets reached $6 billion, almost five times that of the same period last year.

Countrywide Financial Corp shareholders vote on Wednesday to approve the largest U.S. mortgage lender's purchase by Bank of America Corp, marking the demise of the company perhaps most closely associated with the nation's housing bubble and subsequent collapse.

The vote will be held at Countrywide (CFC.N) headquarters in Calabasas, California. A Countrywide spokesman said the meeting is closed to the press and is not being webcast. While the outcome is not in doubt, the proceedings lend an aura of secrecy to the final days of Countrywide, which in 2007 made one in six U.S. mortgage loans -- many of which would not get made today.

They also provide a contrast to last year, when Chief Executive Angelo Mozilo would spend three hours on earnings conference calls, proclaiming the company he co-founded in 1969 had a "much better chance of success" than any rival to survive the shakeout in housing and credit markets. It won't.

"Countrywide joined the crowd in participating in untested lending standards," said Gary Gordon, an analyst at Portales Partners in New York. "It was also Countrywide's mistake to retain substantial amounts of credit risk. It should have stayed a mortgage banker rather than become a mortgage investor."

The merger may close by July 1. Mozilo, the son of a Bronx, New York butcher, faces a U.S. Securities and Exchange Commission probe into his sales of Countrywide stock before it cratered. He now also faces allegations that politically connected "Friends of Angelo" got favorable loan terms from Countrywide.

Countrywide investors got their own final kick in the stomach as the credit crunch began hurting Bank of America's own shares. Through Monday, Bank of America (BAC.N) shares had dropped by a third since the all-stock takeover was announced on January 11. This cut Countrywide's merger value to about $2.7 billion from $4 billion.

Charlotte, North Carolina-based Bank of America also has not said whether it will assume all Countrywide debt. Barbara Desoer, the bank's technology and operations chief, will run the combined mortgage business. Countrywide's name, meanwhile, will disappear.

Three months after Fannie Mae and Freddie Mac won the freedom to step up home-loan purchases, the government-chartered mortgage-finance companies are doing what critics in the Federal Reserve and Congress had predicted. Instead of using powers granted by Congress to buy jumbo loans for the first time, Freddie Mac and Fannie Mae are purchasing their own mortgage-backed securities, helping reduce losses, company filings show.

The large loans, above $417,000, made up almost a third of the U.S. market last year, according to the Mortgage Bankers Association. Since the rule change took effect in March, Fannie Mae has packaged $24 million of jumbo loans into securities, while Freddie Mac added $220 million, according to the Inside Mortgage Finance newsletter. In April, the companies spent more than $32.4 billion to buy their own instruments, regulatory filings show.

"They were granted expanded opportunity to help recovery in a troubled housing market and yet have appeared to focus on their own recovery," said former U.S. Representative Richard Baker, a critic of the companies who left office earlier this year to run the Managed Funds Association in Washington. Congress had kept Fannie Mae and Freddie Mac out of the jumbo market to force them to concentrate on low- and moderate- income borrowers.

The change places taxpayers at greater risk "without facilitating the policy goals I believe the Congress had in mind when they eased these portfolio limits," said Baker, 60, a Louisiana Republican.

The slowness of Fannie Mae and Freddie Mac in injecting cash for new jumbo loans may have exacerbated the housing slump in markets including California and Florida, where prices have already fallen more than the national average, said Jerry Howard, 53, president of the National Association of Home Builders. "Had they been quicker into the marketplace, they could have helped slow the downward spiral in housing prices," Howard said.

Congress created Washington-based Fannie Mae and Freddie Mac of McLean, Virginia, to promote home ownership by increasing financing and providing market stability. The companies own or guarantee almost half of the $12 trillion in U.S. residential mortgage debt. They profit by holding assets that yield more than their debt costs and from fees charged to guarantee bonds they create.

Fannie Mae and Freddie Mac posted record losses of $11.8 billion in the past three quarters as defaults on mortgages soared to the highest in 30 years. The National Association of Realtors estimated last year that Fannie Mae and Freddie Mac would buy $150 billion of jumbo loans in 2008. UBS AG analysts now say the amount may be $74 billion; the companies' own projections indicate that they may not even reach that figure.

Freddie Mac said it would purchase $10 billion to $15 billion in jumbo loans and securities in 2008. Fannie Mae hasn't made any public commitments to buy a set amount of the assets this year.

U.S. mortgage applications fell for a second consecutive week, hitting their lowest level in nearly 6-1/2 years despite a sharp drop in interest rates, an industry group said on Wednesday.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage applications for the week ended June 20, which includes both purchase and refinance loans, dropped 9.3 percent to 461.3 -- the lowest level since the week ended December 28, 2001.

The report offers additional evidence of a U.S. housing market that is suffering one of the worst downturns in its history. Significantly tighter lending standards and an unwieldy supply of homes for sale are some of the factors preventing the U.S. housing market from rebounding out of its two-year-long slump.

The frenzy of foreclosures hitting the market is aggravating matters adding to the supply of unsold homes and depressing home prices nationwide, analysts say. The jump in foreclosure sales explains part of the sharp drop in home prices since foreclosures typically sell at about a 20-percent discount to the market, according to Michelle Meyer, an economist at Lehman Brothers in New York.

"Foreclosures and falling home prices are mutually reinforcing," she said in commentary published on Tuesday before the report was issued. Borrowing costs on 30-year fixed-rate mortgages, excluding fees, averaged 6.39 percent, down 0.18 percentage point from the previous week. Interest rates were also below year-ago levels of 6.60 percent.

The MBA's seasonally adjusted purchase index dropped 7.4 percent to 333.4. The index came in well below its year-earlier level of 428.9 -- a drop of 22.3 percent. Overall mortgage applications last week were 25.4 percent below their year-ago level. The four-week moving average of mortgage applications, which smoothes the volatile weekly figures, was down 6.1 percent to 507.3.

American consumers, battered by falling home prices and soaring gasoline prices, are at their gloomiest in decades, raising fears they might cut back on spending later this year and tip the economy into a recession.

Consumer confidence plunged in June to its lowest level since 1992, and home-price declines accelerated in April, according to data released Tuesday. The renewed signs of economic weakness increased the likelihood that Federal Reserve policy makers, who wrap up a two-day meeting Wednesday, will hold the target for their benchmark interest rates steady at 2%.

The Conference Board, a New York-based business research group, said consumer confidence dropped to 50.4 in June from 58.1 last month. The scale -- which uses as its benchmark a 1985 level of 100 -- peaked most recently at 111.9 in July 2007. Consumers' expectations of the economy six months ahead plunged to the lowest levels since the board began conducting its surveys in 1967.

The economic pullback since last year has been led by slumping home construction and flattening business investment. But growth has remained marginally positive: The economy grew at a 0.9% annual pace in the first quarter of this year and will likely post a similar gain in the current April through June period. That's largely because consumers, whose spending makes up two-thirds of U.S. economic output, have remained resilient.

But the latest evidence of slumping confidence and tumbling home prices suggests that Americans' willingness to keep spending is being tested, and the odds of avoiding economic contraction have dropped. (Economists note, however, that consumers' behavior does not always follow what they say about their confidence.)

"The final quarter [of 2008] could be a big mess," said John Lonski, chief economist at Moody's Investor Service. He noted a host of risks to growth through early next year: rising prices of goods and services, continued pain in the housing market, and a possible slowdown in consumer spending once the impact of federal economic-stimulus checks fades. "That might be when we finally observe back-to-back quarterly declines" in gross domestic product, which typically signify recession, he said.

Will rising global inflation lead to a sharp global economic slowdown? Even worse, will it revive stagflation, that deadly combination of rising inflation and negative growth? Inflation is already rising in many advanced economies and emerging markets, and there are signs of likely economic contraction in many advanced economies (the United States, the United Kingdom, Spain, Ireland, Italy, Portugal, and Japan).

In emerging markets, inflation has – so far – been associated with growth, even economic overheating. But economic contraction in the US and other advanced economies may lead to a growth recoupling – rather than decoupling – in emerging markets, as the US contraction slows growth and rising inflation forces monetary authorities to tighten monetary and credit policies. They may then face “stagflation lite” – rising inflation tied to sharply slowing growth.

Stagflation requires a negative supply-side shock that increases prices while simultaneously reducing output. Stagflationary shocks led to global recession three times in the last 35 years: in 1973-1975, when oil prices spiked following the Yom Kippur War and OPEC embargo; in 1979-1980, following the Iranian Revolution; and in 1990-91, following the Iraqi invasion of Kuwait. Even the 2001 recession – mostly triggered by the bursting high-tech bubble – was accompanied by a doubling of oil prices, following the start of the second Palestinian intifada against Israel.

Today, a stagflationary shock may result from an Israeli attack against Iran’s nuclear facilities. This geopolitical risk mounted in recent weeks as Israel has grown alarmed about Iran’s intentions. Such an attack would trigger sharp increases in oil prices – to well above $200 a barrel. The consequences of such a spike would be a major global recession, such as those of 1973, 1979, and 1990. Indeed, the most recent rise in oil prices is partly due to the increase in this fear premium.

But short of such a negative supply-side shock, is global stagflation possible? Between 2004-2006 global growth was robust while inflation was low, owing to a positive global supply shock – the increase in productivity and productive capacity of China, India and emerging markets. This positive supply-side shock was followed – starting in 2006 – by a positive global demand shock: fast growth in “Chindia” and other emerging markets started to put pressure on the prices of a variety of commodities.

Strong global growth in 2007 marked the beginning of a rise in global inflation, a phenomenon that, with some caveats (the sharp slowdown in the US and some advanced economies), continued into 2008. Barring a true negative supply-side shock, global stagflation is thus unlikely. Recent rises in oil, energy and other commodity prices reflect a variety of factors:

High growth in demand for oil and other commodities among fast-growing and urbanizing emerging-market economies is occurring at a time when capacity constraints and political instability in some producing countries is limiting their supply.

The weakening US dollar is pushing the dollar price of oil higher as oil exporters’ purchasing power in non-dollar regions declines.

Investors’ discovery of commodities as an asset class is fueling both speculative and long-term demand.

he diversion of land to bio-fuels production has reduced the land available to produce agricultural commodities.

Easy US monetary policy, followed by monetary easing in countries that formally pegged their exchange rates to the US dollar (as in the Gulf) or that maintain undervalued currencies to achieve export-led growth (China and other informal members of the so-called Bretton Woods 2 dollar zone) has fueled a new asset bubble in commodities and overheating of their economies.

Most of these factors are akin to positive global aggregate demand shocks, which should lead to economic overheating and a rise in global inflation. Exchange rate policies are key. Large current-account surpluses and/or rising terms of trade imply that the equilibrium real exchange rate (the relative price of foreign to domestic goods) has appreciated in countries like China and Russia.

Thus, over time the actual real exchange rate needs to converge – via real appreciation – with the stronger equilibrium rate. If the nominal exchange rate is not permitted to appreciate, real appreciation can occur only through an increase in domestic inflation. So the most important way to control inflation – while regaining the monetary and credit policy autonomy needed to control inflation – is to allow currencies in these economies to appreciate significantly.

Unfortunately, the need for currency appreciation and monetary tightening in overheated emerging markets comes at a time when the housing bust, credit crunch, and high oil prices are leading to a sharp slowdown in advanced economies – and outright recession in some of them. The world has come full circle. Following a benign period of a positive global supply shock, a positive global demand shock has led to global overheating and rising inflationary pressures.

Now the worries are about a stagflationary supply shock – say, a war with Iran – coupled with a deflationary demand shock as housing bubbles go bust. Deflationary pressure could take hold in economies that are contracting, while inflationary pressures increase in economies that are still growing fast.

Thus, central banks in many advanced and emerging economies are facing a nightmare scenario, in which they simultaneously must tighten monetary policy (to fight inflation) and ease it (to reduce the downside risks to growth). As inflation and growth risks combine in varied and complex ways in different economies, it will be very difficult for central bankers to juggle these contradictory imperatives.

The European Central Bank insists it has signaled only one interest-rate increase; investors are calling its bluff. They're betting the ECB will raise rates twice this year and most predict a third step by March, even as policy makers admonish markets for jumping the gun.

We "didn't say that we could envisage a series" of rate increases, ECB President Jean-Claude Trichet told the European Parliament in Brussels today. One move "should be enough," Executive Board member Lorenzo Bini Smaghi said last week. "There will be at least two rate hikes," said Franz Wenzel, Paris-based deputy director for investment strategy at AXA Investment Managers, which oversees $831 billion. "Whether you call that a series or not is semantic."

Central banks from India to South America are raising borrowing costs as climbing prices replace the global credit crunch as their biggest concern. The risk for the ECB is that higher rates spur the euro and exacerbate Europe's economic slowdown. Trichet on June 5 said the bank may raise its benchmark rate by a quarter-point to 4.25 percent in July to curb the fastest inflation in 16 years.

While some of the ECB's 21 council members have left open the option of further moves, Trichet said others are against raising rates at all. Investors have nevertheless priced in two rate increases to 4.5 percent by December, Eonia forward contracts show.

"There is disagreement among ECB policy makers about the future course of monetary policy, but one increase will simply not be enough," said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Plc in London. "At the end of the day, inflation concerns will rule."

Barclays Plc, Britain's fourth-biggest bank, plans to sell 4.5 billion pounds ($8.9 billion) of stock mostly to investors in the Middle East and Asia to boost capital depleted by credit-related writedowns. Barclays rose as much as 6.4 percent in London trading, the biggest gain in two months, after the London-based bank said in a statement it will offer 1.58 billion new shares to investors including institutions in Qatar, Singapore, China and Japan.

While half the new money will be used to bolster Barclay's capital after financial institutions worldwide wrote down $399 billion dollars linked to subprime-mortgage losses, the rest will be used for "business opportunities out there," including acquisitions, Chief Executive Officer John Varley told reporters.

"We expect the longer-term growth prospects of the company to be higher than its domestic U.K. peers," Merrill Lynch analyst John-Paul Crutchley wrote in a note to clients today. He has an "underperform" rating on the stock. Barclay traded up 5.9 percent at 9 a.m. The shares are down 35 percent this year.

Barclays will offer shares to Challenger, a company representing Qatar's royal family, Qatar Investment Authority, Temasek Holdings Pte, China Development Bank, Sumitomo Mitsui Financial Group Inc. Sumitomo will buy 500 million pounds of new stock at 296 pence a share. Barclays's individual investors will be able to "claw back" the additional 4 billion pounds of shares that overseas and institutional investors have agreed to buy at 282 pence apiece.

By finding overseas investors to guarantee proceeds of the share sale, Barclays isn't relying on investment banks to underwrite the offering. Credit Suisse Group and JPMorgan Cazenove are working with Barclays Capital as joint brokers on the sale.

Barclays's offer of 500 million pounds to Sumitomo is priced at a 4.7 percent discount to the bank's closing share price yesterday. The rights offering of 4 million pounds is priced at a 9.25 percent discount to yesterday's close of 310.75 pence a share. Current investors will be able to buy three new shares for every 14 shares they own.

"It's probably a better way to raise the money than some of the other rights issues," said Leigh Goodwin, an analyst at Fox- Pitt Kelton Ltd. in London who has an "in-line" rating on the stock. "It will be interesting to see if people have confidence," he said.

British banks face slower growth amid higher funding costs and rising defaults as house prices fall at the fastest rate since the recession of the 1990s. The credit-market freeze has halted sales of mortgage-backed securities, which lenders including HBOS and Bradford & Bingley Plc use to fund property loans. Banks have raised about $304 billion to help cover losses since the collapse of the U.S. mortgage market.

UBS AG, the biggest money manager for the wealthy, and Merrill Lynch & Co., the third-largest, had slower growth in assets under management last year after losses tied to the U.S. subprime crisis, Scorpio Partnership said.

UBS's assets from affluent clients increased 8.8 percent to $1.9 trillion in 2007, compared with 13 percent growth the year before, said Scorpio, a London-based research firm, in an annual survey published today. Merrill's assets rose 8.3 percent to $1.31 trillion, slowing from 10 percent in 2006, Scorpio said.

Merrill, based in New York, had the biggest writedowns from the subprime crisis last year, amounting to $27.4 billion, while Zurich-based UBS had $19.1 billion of markdowns. Growth in private-banking assets at Credit Suisse Group AG, the No. 4 wealth manager, almost halved to 6.9 percent. The median increase for the global wealth management industry was 12 percent, down from 14 percent in 2006, even as some smaller banks benefited.

"A number of smaller independent banks have experienced very strong net inflows," said Ted Wilson, a senior consultant at Scorpio in London. "There is a redistribution occurring between types of banks. The pure private-banking model may be the one people feel safest using." Pictet & Cie., Switzerland's largest closely-held private bank, boosted assets under management 30 percent last year to $120 billion, while Bank Sarasin, which is controlled by Rabobank Groep, had a 21 percent increase in assets to $40 billion, according to Scorpio.

"This sort of reputational damage hasn't happened to the market leaders before," Morgan Stanley analysts Huw van Steenis and Bruce Hamilton said in a note last week. They forecast "anemic" net new money at UBS this year and next and "downward pressure on profitability from defending market share."

Ilargi: A comparison: GMAC has more employess than Bear Stearns had, and more assets than Countrywide.

The 300 bankers gathered at New York's Waldorf-Astoria Hotel last month faced a stark choice: Accept Sam Ramsey's plea to restructure $60 billion of GMAC LLC's debt or risk pushing the lending arm of General Motors Corp., the largest U.S. automaker, to the brink of insolvency.

"There was not room for slippage," said Ramsey, 49, a former Bank of America Corp. executive who joined Detroit-based GMAC in September and became chief risk officer two months later. He pulled it off as banks led by New York-based JPMorgan Chase & Co. and Citigroup Inc. provided GMAC and its Residential Capital LLC mortgage unit with the biggest restructuring package since the credit-market rout began a year ago.

Whether that's enough to ride out the worst housing slump since the Great Depression remains in doubt. Moody's Investors Service cut GMAC's credit rating one level to six rankings below investment-grade last week as ResCap burns through cash after losing $5.3 billion in the past six quarters.

"ResCap presents a very significant risk," said Mark Wasden, the lead GMAC analyst at Moody's. "There is no easy exit from their difficulties right now. We think the company will yet again find itself in need of additional cash." Credit-default swap prices give ResCap a 100 percent chance of default within the next five years, based on a JPMorgan model. It was 98 percent before the debt agreement was announced.

GMAC, started 89 years ago by GM, has 27,000 employees, twice the number that Bear Stearns Cos., the fifth-biggest U.S. securities firm, had when it was rescued in March by JPMorgan. GMAC's $250 billion in assets makes it bigger than Countrywide Financial Corp., the biggest U.S. mortgage company by loans, which is being bought by Bank of America. Investors had speculated that ripple effects from those potential failures could have spread to the rest of the U.S. financial system.

GMAC's latest rescue effort began May 2 at 6:30 a.m. New York time, when ResCap released a statement saying it would offer as little as 80 cents on the dollar to exchange or buy back $14 billion of bonds to delay maturities and reduce debt. Shortly before 9 a.m., bankers filtered into the Waldorf's Starlight Roof on the 18th floor, where Guy Lombardo and his Royal Canadians once serenaded New Year's revelers.

As attendees sipped coffee and munched pastries, JPMorgan Vice Chairman James Lee kicked off the event. Then it was the turn of GM Chief Operating Officer Fritz Henderson. Next was Stephen Feinberg, the founder of Cerberus Capital Management LP, who had been instrumental in leading the $7.4 billion purchase of 51 percent of GMAC in 2006.

Separated from the automaker, GMAC's credit rating was supposed to rise from junk, which would have lowered borrowing costs. Instead, the ResCap unit was hit by a cash crunch as subprime home loans started to default. The Minneapolis-based housing unit lost more than $4.3 billion last year, contributing to a $2.3 billion loss for GMAC. ResCap's subprime loans totaled $32.8 billion in March, compared with $36.8 billion at the end of 2007, according to a company filing.

Readers will know that we regularly use the phrase, ‘the tide is going out’ as a simile for the credit contraction. Imagine arriving at Southend for the first time ever and standing on the promenade. Seeing where the sea is you wonder if the tide is coming in or going out. You ask a local and he tells you that it is still going out, adding that when it has fully ebbed, you won’t believe how far out it goes.

That is the analogy that you must carry in your mind’s eye and all extraneous news should be examined through that prism of knowledge. There is an old investment saying. ‘Never try to catch a falling knife’. There have been some good examples of this of late. One of the best is Barratt Developments, the house builder, whose share price has, since last year, collapsed by over 95%.

Remember this, no matter how far the price has fallen, it can always fall another 50%. We have plotted on the chart a series of 50% falls, starting from the all-time high set in February 2007 at over 1310. By October 2007 it had fallen 50%. An optimist might have bought it then but by January 2008 it had fallen 50%. If an optimist had then bought it, by the 26th May it had lost another 50% and if he had bought it there by June this year he would have lost another 50% and it still has not definitely bottomed out.

One of the reasons house builders’ share prices have come under such huge pressure is the collapse in the value of their land banks. One of the simple investment truths is that when the house market is in ascendancy, the gains reside mostly in the land and when house prices are under pressure, the losses also reside mostly in the land. Land is, in effect, a geared play on property.

Consider that you have two identical plots each worth £100,000. A house is built on one plot at a cost of £100,000 and when completed is sold for £250,000. The cost of building that house was £100,000 so in effect the plot could be deemed to have increased in value by 50% to £150,000. Now imagine that time has moved on and the house market is in sharp decline. The house is now worth 40% less, £150,000. It still costs £100,000 to build the house; therefore the value of the land has fallen to £50,000, probably less, a third of its previous value.

If you are a business with a load of this land on your balance sheet, with your corporate debt secured against it, you might by now very well be insolvent. Worse still, there have been times in the past, when house prices have fallen to below the rebuilding cost, suggesting that at such times building land might have no value at all.

The fix that house builders find themselves in is truly awful, because an efficient housing market no longer exists. Of the three housing collapses over the past 30 years, never before have we seen, so early, such a shattering collapse in sentiment. Any valuation index such as the FT House Price Index that tries to put a value on this market is wasting its time.

If you want to know the true value, set up an auction, put houses up for sale with no reserve price and then you will find out the truth. We would bet that the outcome of such a real, mark to market, process for property would cause all vestige of confidence to evaporate.

Asian investors, who own 28 percent of U.S. government debt, are becoming bigger bears on the bond market now that inflation shows no signs of decelerating and the Federal Reserve isn't prepared to raise interest rates.

South Korea's pension service said U.S. yields are "too low" after accounting for inflation. Mizuho Asset Management Co., part of Japan's second-biggest bank, favors euro- denominated debt and plans to purchase more. Kokusai Asset Management Co., which runs the world's second-largest managed bond fund, owns a record amount of European fixed-income securities.

"Europe has held out quite well, avoiding rate cuts, while the U.S. was bold in slashing borrowing costs," said Kwag Dae Hwan, head of global investments at the National Pension Service in Seoul, which holds about $14 billion of Treasuries. "That puts Europe in a better position to cope with inflation now."

Consumer prices will rise 3.8 percent this year in the U.S., versus 2.8 percent in the euro region, according to the median estimate of economists surveyed by Bloomberg News. U.S. 10-year notes yield about the same as the inflation rate, compared with an average of 2.03 percentage points more over the past decade. Investors can get more protection in Germany, where 10-year bunds yield 1.52 percentage points more than inflation.

The U.S. 10-year yield was little changed at 4.18 percent by 3:27 p.m. in New York. The yield on the equivalent European security fell 4 basis points to 4.59 percent. Foreign investors, who hold almost half of the U.S.'s $4.69 trillion in marketable debt, are important because their purchases help finance the federal budget deficit, which is approaching the 2004 record of $413 billion. The deficit in May was $165.9 billion, bigger than the shortfall for all of fiscal 2007, according to the government.

If demand were to erode, it might drive down debt prices, adding to a slump that has put the U.S. bond market on the brink of its worst quarter in a generation. Treasuries have fallen 3.1 percent since March, their poorest showing since losing 5.06 percent in the third quarter of 1980, according to Merrill Lynch & Co.'s U.S. Treasury Master Index. German bunds due in 10 years yield 48 basis points, or 0.48 percentage point, more than Treasuries of similar maturity. That's up from 17 basis points on May 13, and compares with the high this year of 56 basis points on Jan. 22.

Purchases of European debt by Asian investors, who hold more than $1.3 trillion in U.S. government bonds, are a vote of confidence in European Central Bank President Jean-Claude Trichet, who has kept the continent's benchmark rate at a six- year high of 4 percent as Ben S. Bernanke slashed the Fed's target to 2 percent from 5.25 percent in September.

Bernanke "panicked" as financial-market losses spread, said Allan Meltzer, the 80-year-old Carnegie Mellon University professor who has written a history of the Fed. Former U.K. Chancellor of the Exchequer Nigel Lawson, 76, said Bernanke may be "regretting" the cuts as global inflation accelerates.

The home loans market has collapsed to the weakest level on record as the credit crunch "throttles" families' finances, new figures have shown. The number of mortgages approved by Britain's biggest banks fell last month to the lowest level since records began 11 years ago.

Approvals dropped to just under 28,000 in May - a 20 per cent fall in the past month, and a 56.1 per cent fall since May last year, according to figures from the British Bankers' Association. It came as Chancellor of the Exchequer Alistair Darling threatened to take action on lenders if they treated households unfairly by raising their mortgage rates too sharply.

He said: "I'm very concerned that people ought to be treated fairly, especially people coming off fixed rates and going onto different rates. "We have met the Council of Mortgage Lenders to try to reach an agreement to ensure that people are treated fairly, but if that isn't happening I will ask the [Financial Services Authority] to pursue the matter."

Experts warned that the fall in mortgage approvals presaged a further drop in house prices. They said homes could lose a quarter of their value or more over the coming years. It is the latest piece of bad news for the housing market, where prices are already almost 5 per cent lower than last year.

Michael Saunders, chief UK economist at Citigroup, said: "These figures highlight again the extreme weakness of the housing market, caught between over-inflated values, high household debts, erosion of real incomes via high inflation, and the credit crunch. "Our base case – base case, not worst case - is for house prices to fall 20 per cent. It may turn out even worse than that."

The BBA reported the total amount of mortgage debt increased by only £4.3 billion in May - the second lowest rise since 2002. In a further sign that consumers are struggling with their finances, spending on credit cards rose to £7.5 billion, with households failing to repay more than they spent for the first time in 18 months.

Howard Archer of Global Insight said: "The BBA data graphically highlight that housing market activity is currently being throttled by stretched affordability and tight lending conditions. We forecast house prices falling 24 per cent in nominal terms from their August 2007 peak of £199,600 to stand at £152,683 at the end of 2009."

"Obviously the more that house prices fall, the more people will be trapped with negative equity, although it must be borne in mind that average house prices rose by 190 per cent over the decade to August 2007 on the Halifax measure. Nevertheless, those people who took out 100 per cent or even 100 per cent-plus mortgages within the last two years are particularly vulnerable to falling into the negative equity trap."

Up to 350,000 UK jobs could be axed over the next 18 months as firms continue to suffer in the economic turmoil, a new report has claimed. As rumours circulated of fresh job cuts at Citigroup and Goldman Sachs, research released today showed that UK companies of all sizes expect to cut staff and suffer lower profits until at least 2010.

According to the study, published by Hay Group and the Centre for Economic and Business Research, business leaders expect to cut their workforces by an average of 1.1%. This equates to around 350,000 job losses. "UK business are facing the most challenging economic environment for more than a decade, as the impact of the credit crunch ripples across the economy and inflation picks up as input prices rocket," said John Ward, managing economist of the CEBR.

A large chunk of the job losses are expected to involve the financial services sector, where companies have been most exposed – and in some cases responsible – for the credit crisis. On Sunday the Wall Street Journal reported that Citigroup – which has lost £7.5bn in the last six months - is planning to axe 6,500 posts from its investment banking division. This is expected to include some cuts in the UK, and could be announced this week.

Goldman Sachs, which appeared to have fared better through the crisis, is reportedly planning to cut 10% of its investment banking staff.

Ilargi: US cities, counties and states will be forced by plummeting revenue to cut services to levels nobody today can even imagine. Millions of people on government payrolls will lose their jobs. The worst economical hits will be those close to home.

The latest hit to the economy could come from state houses and city halls across the nation, which are in their worst budget crisis in years. With falling revenue from sales and income taxes, and property-tax declines looming, states, cities and towns have already laid off tens of thousands of government employees. Many expect more job cuts ahead as public officials struggle to balance their budgets.

The American Federation of State, County and Municipal Employees, a public employees union, says about 45,000 government layoffs have been announced this year. All but four states are set to begin their new fiscal years on July 1, which means that tough decisions will have to be made soon. Economists say that cutbacks in jobs and spending by local governments could be a major drag on the overall economy.

"This isn't a wrecking ball to a healthy economy, but it could be the straw that broke the camel's back," said Bob Brusca, economist with FAO Economics in New York. There are 29 states, including California, Florida and Ohio, facing a combined budget shortfall of at least $48 billion in the fiscal year that starts July 1, according to the Center on Budget and Policy Priorities (CBPP), a liberal think tank.

The National Association of State Budget Officers estimates that spending by all 50 states will be up 1% in fiscal 2009. But that would be the third lowest increase in the past three decades. There are nearly 20 million state and local government employees in the country. So a 1% decline in employment at cities, towns, schools and states would result in a job loss of almost 200,000 people, a much larger amount than we've seen from battered sectors such as automakers or home builders in the past two years.

Even in states, towns and cities not yet laying off people, hiring freezes and early retirement packages are now common, said Robin Prunty, senior director in the public finance department of credit rating agency Standard & Poor's.

Surging fuel prices are forcing cities across the United States to cut back on services and dip into cash reserves to keep their fleets on the road, according to a survey released on Friday. Ninety percent of the 132 mayors surveyed by the U.S. Conference of Mayors reported that climbing fuel prices have had a significant impact on city budgets and operations.

The average retail price of diesel used in city buses and garbage trucks has shot up 65 percent over the past year. Gasoline prices jumped about 35 percent over the same period, as many local governments are feeling the pinch of the wider nationwide economic slowdown.

"It's just a snowball. It all hits at once. So, governments, mayors are having to make tough choices," said Mayor Douglas Palmer of Trenton, New Jersey. "Everything is on the table except for a reduction in public safety." Just under a quarter of the mayors surveyed -- 23 percent -- said they have been forced to slash spending for other programs in order to pay mounting fuel costs.

Seattle Mayor Greg Nickels said his city has raised its fuel budget by about 50 percent at the expense of other services including the police department. "We could have added more police officers to the budget. We're having to look real closely at our parks program," Nickels said, adding Seattle might be forced to cut back on community centers and library hours if prices continue to rise.

Ilargi: Another guy gone who doesn’t get Bulgarian politics. I have warned of what will happen to pension funds for years. We’ll see so much more of this soon, it’ll seem normal. Pension funds are among the biggest losers in the credit disaster, and only their secretiveness keeps the managers in their jobs for now. If you have any options to do so, start questioning your fund.(thanks dave)

Gov. Rick Perry has removed Dallas investor Frederick "Shad" Rowe as chairman of the Texas Pension Review Board, which oversees nearly 400 public pension systems that hold $200 billion in assets. Rowe said Monday he attributes the move to his repeated warnings about financially troubled pensions and his sharp criticism of some pension systems' investment strategies.

Allison Castle, a spokeswoman for Perry, said that the governor thinks "it is important that the leadership of boards and commissions do what is in the best interest of the state and not pursue their own personal agenda." She declined to say what the governor thought Rowe's agenda was. "I do have an agenda: total candor," said Rowe, who is chairman of Greenbrier Partners, an investment fund in Dallas.

"I have been in the business of investing for a long time. I have been with the pension review board since 1997," he said. "I presumed I had built up enough credibility that I could 'tell it like it is' without worrying about politics. I believe underfunded public pensions and other expensive promises represent a fiscal time bomb. Those at risk — pensioners and taxpayers — deserve nothing less than total candor." Rowe said he has not spoken to Perry, who appointed him as chairman of the board four years ago.

Perry named Richard McElreath, a financial adviser in Amarillo, as the new chairman of the pension board. Rowe said a Perry aide, Natalie Foerster, in recent weeks had asked him to stop talking to reporters and to stop soliciting help from the office of Texas Attorney General Greg Abbott. Abbott's financial litigation division last year investigated the City of Fort Worth's troubled pension fund at the pension board's request.

The resulting report said city and pension fund officials had used misleading and unrealistic assumptions for the fund and approved benefit increases without considering their financial impact. Castle said it is "not the case" that the governor's office asked Rowe to stop working with the attorney general. But she said, "It's important that there ... be an opening of the lines of communication before going to the attorney general."

Rowe could be a sharp critic of what he called "the backwards-looking approach to investment" by some pension funds. Rowe said too many pension fund directors, worried about missing out on the next great trend, have poured money into commodities, private equity and other alternatives to stocks and bonds without fully considering the risk. At the April 11 board meeting, he criticized pension funds' reliance on investment consultants "who attempt to reduce what they call 'risk' by patching together a crazy quilt of ... assets."

State Sen. John Whitmire, a Houston Democrat who serves on the pension board, said Rowe was "a positive influence" who "helped professionalize the review board and get additional resources." But he might have overreached, Whitmire said, particularly in asking the attorney general to get involved in examining public pensions.

More than a century and a half after Mexico lost Texas to the U.S., Virgilio Garza wants a piece of it back. A "Texas for Sale" sign and cowgirls in boots and white hats greeted Garza at the Convex center in Monterrey, Mexico, earlier this month. A Monterrey developer and investor, Garza was in search of foreclosed U.S. property to buy.

"Texas is like our home," said Garza, 45, who joined hundreds of Mexicans poring over lists of Texas properties at the four-day event. Garza, who owns manufacturing sites and other land in Mexico, said he and five partners may invest as much as $8 million in Texas. "We believe there can be some opportunities," he said.

A rising peso and an economy growing faster than the U.S. have given some Mexicans the buying power to take advantage of the housing slump in Texas, which became part of the U.S. under an 1848 treaty that ended a three-year war between the two countries.

The peso has gained 3.2 percent against the dollar since the beginning of the year. The economy, which rose 2.6 percent in the first quarter from a year ago, is expected to grow 2.6 percent this year, according to a central bank survey of 31 economists in May. The U.S. economy is forecast to grow 1.4 percent in 2008, according to a Bloomberg survey of 57 economists.

Marco Ramirez of McAllen, Texas, is among those trying to sell foreclosed Texas homes to Mexicans. Ramirez's company, called Now! Co., has bought 32 Texas properties and has options on 88 more. His best prospects are Mexican buyers, especially in Monterrey, 150 miles from the Texas border, he said.

"Many of these people have children who are studying in the U.S.," Ramirez said. "They've been renting or leasing and now it's a great time to buy." Mexico is better known for providing the U.S. with cheap labor than investment. The U.S. is home to an estimated 12 million Mexican-born residents, about half of them living there illegally, according to the Pew Hispanic Center in Washington.

Sales of existing U.S. homes in April fell 18 percent to an annual pace of 4.89 million from 5.93 million a year ago as banks shied away from making new loans, according to the National Association of Realtors in Washington

California farmer Mike Wood has let $150,000 worth of cotton die. Barry Baker spent $2.5 million to obtain water rights on the open market to salvage his crops. Shawn Coburn is risking long-term damage to his land by pumping water from a 1,200-foot well.

California's first drought since 1992 has pinched the spigot for farmers in the largest U.S. agricultural area. Along the western edge of the San Joaquin Valley, water supply has been reduced by about 50 percent, leading farmers to abandon crops and spend millions of dollars on short-term solutions.

"If the drought were to continue and everything that has been associated with it at the same time were to continue, I don't see myself in this business in five years," Wood, a third- generation farmer, said in an interview at his farm in Firebaugh, about 150 miles southeast of San Francisco.

After two years of below-average rainfall, diminished snowmelt runoff from the Sierra Nevada Mountains and court- ordered water-transfer reductions to protect an endangered species, California Governor Arnold Schwarzenegger declared a drought and deemed nine counties disaster areas because of the economic strain and potential rise in food prices. Schwarzenegger wants to sell $11.9 billion of bonds for new water projects.

The region supplies tomatoes, almonds, grapes, melons, broccoli, cauliflower, lettuce, wheat, onions, garlic and other produce used throughout the U.S. Fresno County, one of the disaster areas, is the largest agricultural county in the U.S., producing $4.8 billion in crops a year, according to the Fresno County Farm Bureau.

"I'm very concerned -- panicked is probably a better word," said melon broker Stephen Patricio, a former chairman of the Western Growers Association, which is based in Irvine, California. Westlands Water District is among the areas facing supply cuts after the state's driest March, April and May in more than 85 years. State precipitation is 80 percent of average and snowmelt runoff is 60 percent of normal, according to the state Department of Water Resources in Sacramento.

The Westlands district covers 600,000 acres (240,000 hectares) of land that accounts for about 20 percent of Fresno County production. "We lost the ability to use 50 percent of our supply in the three months of the summer when we need it most," said spokeswoman Sarah Woolf.

The drought has pushed water prices on the open market to about $1,000 per acre-foot, or 10 times the amount charged by the U.S. Bureau of Reclamation, Woolf said. An acre-foot of water is equivalent to about 326,000 gallons, or as much as one to two families use in a year.

Anglo American, the London-based mining giant, is to make what is believed to be the largest foreign investment in Zimbabwe to date, just as the British Government puts pressure on companies to withdraw from the country. Anglo will invest $400 million (£200 million) to build a platinum mine in Zimbabwe — a move that has raised concern among some of the company’s shareholders and been condemned by politicians.

The Foreign Office was investigating tonight whether the company’s investment breached sanctions against Zimbabwe. Anglo insisted that its involvement in the country did not break the law. The decision, which was criticised roundly as likely to give succour — and possibly money — to the Mugabe regime, is in stark contrast to the policy of nearly all other main British corporations in Zimbabwe. They are either withdrawing from the country or waiting for Mr Mugabe to be deposed before expanding their businesses.

Lord Malloch-Brown, the Foreign Office Minister, said this week that Britain could push for tougher sanctions against Zimbabwe and put pressure on companies doing business there to withdraw. The Government will also call a halt today to next year’s tour of England by the Zimbabwean cricket team.

International condemnation of President Mugabe and his regime intensified today when the UN Security Council issued a statement condemning the “campaign of violence against the political opposition ahead of the second round of presidential elections”. Despite the political concern about President Mugabe’s regime, Anglo American is pressing ahead with its plans to build a mine at Unki, in central Zimbabwe.

The company employs 188 people and a further 450 contractors at Unki and hopes to be producing platinum, one of the world’s most expensive metals, by 2010. A spokesman for Anglo said: “We are developing the Unki platinum project because we have responsibility to our employees, contractors and the local community. We are keeping the situation in Zimbabwe under close watch.”

Yesterday Ilargi noted that this financial mess is far larger than the oil problem. I agree with that sentiment and I agree with the observation that, because this was a bubble, that it had to eventually burst. I still believe, however, that rising energy prices were the "pin" that started the deflation.

I also agree with Ilargi's observations about energy - that you've really seen nothing yet. After we hit bottom, the skyrocketing relative price of energy will make any attempt at ascension again a very hard, slow, and difficult affair, if it is even possible. (I say relative because even if energy prices go down, everything else is likely to decline more, simply due to fossil fuel scarcity. This, in turn, changes how much "disposable" income we have for other things. In short, energy costs will ultimately consume a larger part of our future budget, regardless of how we denominate that budget.)

A more likely scenario, in my own mind, is that economic collapse acts as the trigger to catabolic civilization collapse, which will occur in steps over decades or even a few centuries.

While it is impossible to be completely independent of the "system" today, you should be as independent as you can manage. And I strongly recommend printed books preferably on paper that is unlikely to deteriorate for a long, long time (acid free, preferably).

If we begin a catabolic collapse, access to the internet will dwindle away over the first decade or two and knowledge will become priceless for future generations. Remember, that in just two centuries from 400 AD to 600 AD, as Rome fell, Britain lost all traces of knowledge about something as simple as a potting wheel. People who think we won't forget don't seem to grasp the enormous effort we spend even today at trying to educate each generation. When we do not have the time to do that, forgetfulness will become the easy way out and knowledge will be lost unless preserved in some other form.

I still can't even imagine how energy got the economic crisis started. I see that, and I use your own words against you, as "I still believe, however, that rising energy prices [..] started the deflation. That is, far as I can tell, you have some religious sort of interpretation of events. Can’t do much with that. How did it happen, pray tell? How did energy cause overleveraged Wall Street casino’s?

What I do see is the possibility, as I have mentioned before, and which, as I have always maintained is for entertainment purposes only, that Hubbert's 1950's lectures were not, as they were publicly, rejected privately by Da Big Boyz, but were taken very seriously. That would make a ton of sense: power cannot afford to mistake these things.

Their conclusion would have been that starting in the late 1970's, provisions had to be made to start preparing the end of US society, while making sure its citizens would be as useful as possible for military purposes. In the past 30 years, US defense budgets have outdone those of the rest of the world combined. Check. The US (and EU) population is deeper in debt than any one society in history. Check. That gives you a great claim on them: prison or the army. Halliburton built camps for millions. Check. Need I say more?

As for education, you talk about: ”the enormous effort we spend even today at trying to educate each generation.

I don’t think so. That sounds terribly naive.

I think that instead, "we" have spent large efforts trying to NOT educate our kids. We have a world full of people helpless in any kind of world that does not include electricity, oil and food from supermarkets. That helplessness comes in very handy if you want to control a population.

Ilargi, When you first spoke of the Bulgaria Model I thought only of living in it, the struggle. I have a more nuanced understanding after to-day's posting. I had not thought about the leadership of a Bulgaria model.I am wondering where Canada fits on the Elliott wave charts? In FT to-day Martin Wolf is worried about stagflation. He is usually very sanguine. to-day he used emotional language which he rarely does as in " the challenge is huge, unpleasant new threat,the shocks are large,greater danger".He describes the financial crisis as " avoidable stupidity". For him the energy crisis is the serious one.

"Figure 5 shows total RMBS issues expressed as a percentage of GDP for nine countries." Apologies, but I do not understand that graph in the context of the article. What should the level of securization tell us about the value of the underlying asset? Germany had a magnificant real-estate bubble in the nineties without having any RMBS...

No wonder the author himself is confused about the graph. The US numbers look way too low for my taste. The regulatory environment is also quite different for the markets, which will also have an impact on the development of the RMBS market.

When there is a prolonged shortage of fossil fuels, our society's palor will turn from ruddy to pale before seizing with rigeurmortis and finally disintegration will ensue. Catabolic collapse is something that happens in Detroit. There are much more sudden and catastrophic forms of collapse including poisoning,warfare and natural disaster (credit crunch?).

It is not a good sign when a damaged system cannot heal its own wounds as in New Orleans. It means that the organism does not have the resources to defend its ordered state. You will see this also in the disintegration of infrastructure, the bankrupting of medicare, the inability to keep 5,000 pound chunks of steel rolling on our highways and so on.

The financial bubbles may have supported the U.S.economy at the expense of foreigners primarily while the oil/food was being secured in the Middle East. After all, money is worthless without commodities and oil is the most important commodity of all.

I think, in real world terms (as opposed to financial terms), that the slow phase of the catabolic collapse began over thirty yeas ago, probably as energy per capita peaked globally. The ensuing period may not have looked like collapse, but it was a slow self-consuming degradation nonetheless, and it was setting us up for a fast crash.

By way of financial analogy, few would say that we have experienced a market collapse since 2000, but we have in real terms. It just happens to have been disguised by continual expansion in nominal terms. The value of the DJIA has already crashed by approximately 70% in real terms (measured against gold and many other stores of real wealth), but almost no one has even noticed. Now, however, we are about to witness (over the next couple of years) a collapse in nominal terms as well, which will suddenly become horribly obvious to everyone.

During the slow catabolic phase of the financial crisis, real wealth was consumed in order to drive a phantom credit expansion, but the virtual wealth we thought we had created was illusory and will disappear as the credit bubble implodes.

Back in the physical world, we have been consuming natural capital (rather than living off the 'interest') for a long time, while using that bounty to expand our population enormously and lock in all manner of structural dependencies. We have been converting capital to waste, as Greer would say, even though it may not look like that at the moment, while we still have the energy to run what we have built. Once that is no longer the case, we will see that we have been engaged in a negative added-value exercise for a very long time.

The means to sustain ourselves has been cannibalized, as phantom wealth expansion and real population expansion have progressed, and now we have to pay the piper. This phase won't be slow or gentle. We have set ourselves up for a population crash of epic proportions, of which the rapidly evolving financial collapse is only the first system shock.

We concentrate on finance here as the time frame is shorter than the effects of peak oil or climate change, meaning that people must get their financial affairs in order first, or there will be nothing they can do to prepare for other looming problems set to affect us later. Those who don't deal with the short term - who underestimate the importance of the financial system in comparison with physical systems - may not have a long term to worry about.

When discussing bubbles with various folks, I always used to cite the tulip mania event. Recently though, a couple revisionist writers have cast doubt about it all, that it wasn't as big, or bad, as usually stated, and/or that the causes were not so straightforward.

I'd be interested in your opinions. I miss my tulip bubble, it was such a lovely illustration, and all the better for being based on such a nonsensical object; one with no intrinsic value at all.

Can I have my tulip mania back, please? :-)

A big part of the housing mess is that the actual value of a house (it keeps the weather outside) was completely confused with its imaginary value as an "investment". I really don't NEED all the bells, whistles, pools, views, etc- to keep my family in; "wanting" it just doesn't have the same force.

Dramatic declines in the indexes are coming soon enough. The more time it takes, the more time people have to get their affairs in order. I think the bulk of the declines will come in the relatively early stages of the collapse - the next couple of years.

I think we'll see a crash to, say, DJIA 500 (ie over a 95% fall) by 2012-2014, with a housing price crash of at least 90% (with local variations) over the same time frame. The resulting deflationary depression should last until at least 2020 I would guess, and even that should be only the first phase in a larger unwinding process.

The last time we had a bubble of anything like this magnitude (smaller, but still significant), the decline lasted for decades, following a very rapid initial collapse, and culminated in a series of revolutions. That was nearly 300 years ago (see the South Sea Bubble of the 1720s).

The Tulipmania of the 1630s was indeed a classic bubble and a good illustration of bubble/mania psychology - an extreme manifestation of human herding behaviour followed inevitably by the opposite extreme, as is always the case. That's how positive feedback works - overshoot and undershoot as greed is followed by fear - even when the object of everyone's affection has no intrinsic value at all.

Human herding behaviour is fascinating to watch, and has driven so much of history. For a good review of historical bubbles, see Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay (published in 1865 but still available.)

I agree. Although I think we'll see a fast crash, and in the relatively near future too, I expect that to be followed by a long period further decline (by which I mean socioeconomic decline rather than a long period of money supply contraction). We begin with credit implosion and proceed with further catabolism in a much poorer and more unstable world.

As you say, and I have said before, the relative price of energy is the important factor. Even if its price declines in nominal terms, that doesn't translate into greater affordability. Energy should decline by much less, and for much less time, than almost everything else. A far greater percentage of a far smaller amount of purchasing power will be required to obtain it, which will result in increasing suffering for most people.

When Jeff Brown (Westexas on TOD) talks about deflation in most things and inflation in food and energy, it is this scenario he is talking about, although he muddies the waters by using a different definition of inflation and deflation (rising and falling prices rather than a rising or falling money supply).

ilargi, maybe you would allow that once the US oil production peaked the free ride of cheap energy and profits started to slow?

This is not the same as to say it was the cause of the current economic problem, merely that it underlays it.

A bubble or that ponzi scam are man made responses to the big fear of not having or being able to keep enough wealth for ones health and enjoyment or in another term 'just plain greed'. A diminishing energy source I would venture, while not the ever repeating problem we are experience, is a contributing factor.